INTRODUCTION. TRADITIONAL FINANCIAL RELATIONS
The Sales and Operations areas must understand and speak the same language as the Financier to understand and take the pertinent actions in their respective fields and make themselves understood properly. Before, during and once the continuous improvement projects have been implemented in the different areas of the company (Sales, Operations –Shopping, Logistics, Production, etc.-) the Financial area must evaluate how they are or are working and it is necessary make evaluations of how the company has been affected and for this, some tools are used such as Relations or Ratios or Financial Indices. This tool is useful for interpreting the reports used by Accountants and Financial: The Balance Sheet and the Income Statement.
The statement of financial position, also called Balance Sheet or balance sheet, is a financial report or accounting statement that reflects the situation of the equity of a company at a certain time. State financial situation structure through three economic concepts, the Active, the Passive and Heritage net.
Equity = Total Assets - Total Liabilities.
The statement of income or status P osses and G anancias, is that ordinate shows in detail how and how the outcome of the exercise was obtained for a given period, the concepts and amounts of income and expense statement.
The P / G status is dynamic, since it covers a period during which the costs and expenses that gave rise to its income must be perfectly identified. Therefore it must be applied perfectly at the beginning of the accounting period so that the information it presents is useful and reliable for decision-making.
The Reasons and Financial Indices are relationships between components of the Balance Sheet and Income Statement (P osses / G anancias). They provide a quick and global visualization of the company's behavior, showing possible strengths and weaknesses in the performance of the different areas. Mainly they focus on measuring : Profitability, Liquidity, Indebtedness or Leverage, Activity or Administration Efficiency and Market Indicators. (The latter will not be analyzed in this document.
The use of these indices gives a clue where to focus the detailed analysis of what to look for and analyze specifically. The financial ratios or ratios obtained may vary enormously from one type of company to another and with greater reason from one business sector to another, therefore they should NOT be analyzed as an absolute value mechanically. Its use should be complemented with other concepts that allow for a more complete evaluation, and will be discussed in the development of this document.
Profitability Reasons
These indices allow us to evaluate the income or profitability of the company in percentage terms, either in relation to its Sales, Assets or Equity.
They measure the effectiveness and efficiency of administration by relating the benefit generated by an investment based on the amount of the investment itself. They relate the ability to generate funds in the short-term operation of the company. They assess whether the profit produced in the period is sufficient for the business to continue operating. Negative figures reflect a loss of assets that require higher financial costs or capital injection by owners or shareholders to keep the business afloat, this being a critical negative scenario.
Profitability is analyzed: On Assets, On Equity, On Sales and On Shareholders.
Return on Assets (ROI) = EBIT / Average Total Assets
The administration of the total resources (total investment) is evaluated and therefore is the measurement of the profitability of the business. EBIT is used to see the ability to generate profit against assets without these being influenced by how they are financed. This relationship is useful for analyzing the operational performance of a company's divisions.
ROI = Return On Investment
EBIT = Earnings Before, Interest, Taxes.
Return on Equity (ROE) =
Net Income / Average Equity = EBIT - Interest - Taxes / Average Equity
ROE = Return On Equity
The return on investment of the owners is measured after interest and taxes, it is the capacity to generate profit for the owner or shareholders.
For corporations, the following is used:
Shareholder Return = {Share price (end-initial) + Dividends} / Initial Share Price
It is what shareholders earn in a period.
Profitability on Sales = Profit / Sales
Liquidity Ratios
They indicate the payment capacity of a company in the short term. They give the ability to convert short-term assets into cash to meet short-term obligations. It is the relationship between Current Assets and Current Liabilities
Working Capital = Current Assets - Current Liabilities
It is the availability of the company to develop its activities. The higher the index or the greater the positive difference, the greater the possibility of paying short-term debts.
The main reasons for Liquidity are: Current Ratio, Acid Test and Absolute Liquidity.
Current Ratio or Current Index = (Total Current Assets) / (Total Current Liabilities)
It is the level of security of creditors to collect in the short term. Its collection is backed by assets that are expected to be converted to cash upon maturity of the short-term debt. The higher the index, the more liquidity, but it must be balanced to avoid having the money without producing. This index can be distorted by the incidence of the seasonal market affecting inventories and sales, among other more concepts.
Acid Test = (Total Current Assets - Inventories) / Total Current Liabilities
It is the ability to pay short-term obligations with the most liquid assets. It is prudent not only to subtract inventories but also accounts receivable that are unlikely to recover in the short term and those that may become uncollectible. There are global economic factors such as inflation that strongly influence these indices. Having high liquidity with high inflation instead of covering accounts payable or investing with high interest rates is losing purchasing power, resulting in poor profitability. As previously mentioned, it is necessary to analyze not only the absolute value of the index but together with other indicators and conditions of the moment. Additionally, remember that financial relationships alone are like a photo –static- and not like a movie –with greater visual-
Absolute Liquidity Index = Cash + Bank + Average Negotiable Securities / Total Current Liabilities
It is the highest liquidity indicator of a company and considers only those Current Assets that do not have any restriction for their transformation into money, that is, cash, balances in current accounts, and investments in negotiable securities of easy and medium liquidation.
Debt or Leverage Reasons
These indices allow us to know how the company finances its Assets with debt to third parties, either in the short or long term, and their relationship with Equity. They indicate the capacity to fulfill the obligations contracted both in the short and long term. They reveal to what extent the company is committed to creditors and how much the company belongs to the owners. It shows the level of risk run by those who offer additional financing to the company being analyzed. Debt is normally a cash flow problem. Again this index must be analyzed in conjunction with other factors and concepts such as Equity. The greater the Equity in relation to the Liabilities, the possibilities of subsistence are greater.The analysis must take into account national and international conditions, since if there are opportunities to obtain financing at very low interests comparatively speaking, it is convenient to obtain leverage and improve the return on capital of the owners. The opposite happens in times of high and very high inflation.
The Debt or Leverage ratios are : Leverage Ratio, Ratio of Total Liabilities to Total Assets and Ratio of Interest Coverage.
Leverage Ratio = Total Liabilities / Equity
It shows the financial support that the company has through its creditors in relation to the money contributed by the partners. This relationship is also made separately for Current (or short-term) Liabilities and Long-term Liabilities instead of Total Liabilities.
Total Liability / Total Assets Ratio is the proportion of funds supplied by creditors financing the Assets, as in the previous case, is made for Total Liabilities, as well as separately for Current and Long-term Liabilities.
Interest Coverage = EBIT / Interest Expense
EBIT = earnings before interest and taxes. (E arnings B efore I nterest, T axes)
This ratio is determined on a pre-tax basis since interest is tax deductible. It shows how far the profits can bear covering interest.
Reasons for Administrative Activity or Efficiency
These indices allow us to assess whether the company's resources have been well invested, the speed of recovery of collections and to know the activity levels of the production and / or sale of the products that the company manages. Sometimes sales grow with a reasonable margin and despite this there are cash flow problems, these indices help us uncover the causes, they can be large inventories or their slow movement or slow collection of accounts.
Inventory Rotation = Cost of Products Sold / Average Inventory
Indicates the number of times that the investment in materials is sold and replenished in the period analyzed. Dividing the days of work per year by the inventory rotation has the days it takes for the investment in material to recover. Decreasing inventory turnover is indicative of a capital increase with no inventory movement. There is a very big difference in inventory days between companies even in the same line of business, because although they make similar products, some can follow “Push” systems and others “Pull”; the former will have large inventories - comparatively - while the latter will be reduced according to their calculated kanban and supermarkets determined to deliver fair quantities according to the requirements of their clients. However,The financial area of each company will judge based on a reasonable "average" of turnover. A difference based on said "average" will be the basis that they will normally use to rate the activity carried out. It is necessary to verify that the inventory does not become obsolete (some branches of the industry suffer a lot with this factor: electronics, fashion in general, etc.) or take care that it is not damaged or perishable.
Average Collection Period
= Balance in Accounts Receivable / (Credit Sales / 365 Days)
= Business Year (in days) / Accounts Receivable Rotation
It is the time that elapses from when it is sold until it is collected, reflecting the collection policy and its tolerance. A tolerance greater than the standard followed by the same industry turn can reflect different things: sales strategy in a restricted market, or they can be problems of bad credit management, seasonality, etc.
Accounts Payable Rotation = Annual Credit Purchases / Accounts Payable Average
Average Payment Period = Accounts Payable Balance / (Acquisitions / 365)
= Business Year (in days) / Accounts Payable Rotation
It is the time it takes the company to pay its bills. If the period is less than the industry standard, it can be due to several things: You are not using the maximum leverage capacity, you are paying in advance for an extra benefit of prompt payment, etc. If you exceed the average period in the industry, you are overusing the financing and you may have problems with having your credit canceled or your credit period reduced.
As a general rule, it is always desirable that the average payment period be greater than the average collection period, since it would mean that we charge in less time than we take to pay, that is, a part of our financing as a company comes from our providers
Asset Rotation = Annual Sales / Total Assets.
It is the efficiency with which the investment of assets is used to generate sales, that is, how many times an amount equal to the investment can be sold. High rotation is indicative of efficient handling.
RECOMMENDATION:
It is very important to emphasize again that for the interpretation of the relationships, indices or ratios it must be taken into account that: By themselves their meaning is not conclusive, they must be interpreted as a whole in analysis by time series seeing intra-company trends. If you choose to include an analysis between companies of the same line of business, you must do it with great caution, taking into account the sector or activity or the type of business in question, not forgetting to take into account the large differences that may exist in the objectives. strategic between companies. Some are not ISO-9000 certified nor do they follow Lean Manufacturing or Six Sigma or Kaizen and therefore have a different vision on inventories.Still others do not contemplate the evolution of the global economy and are governed exclusively by the local or exclusively national economy because it is their market environment. If doing a cross-analysis or inter-company (benchmarking), care must be taken that:
- Companies are in the same sector and business. Similar size. Use similar accounting methods. Located in similar geographical areas. Similar political and economic conditions. (Some countries subsidize certain sectors)
As you can see, a good financial analysis is far from just doing arithmetic. Extensive experience is required and is acquired through constant analysis over time. This document is basically to handle the language and to have an overview of some of the tools that are of basic use for experienced Accountants and Financials.
Compared Financial Statements against Industry over time.
Comparison of financial ratios can vary over time and with industry averages are highly likely to produce statistics that can reveal strengths and weaknesses and correlations can be determined. Analyzing the trends in the graphs shown below is a technique that can be useful when incorporating time and averages of the financial ratios of the industry. In the graphs the dotted line shows the projected ratios. The four basic sources of industry average financial ratios are:
Analysis of trends in financial ratios
- Industry Norms and Key Business Ratios from Dun & Bradstreet; shows fourteen different ratios based on industry averages for 800 different types of businesses. The reasons are presented by Industrial Classification Standard (ECI) and are grouped by annual sales into three categories. Annual Statement Studies by Robert Morris Associates; reveals sixteen different reasons based on industry measurements. Industries are presented by ECI number published by the Census Bureau. The ratios are presented in four size categories measured by annual sales and "for all companies" in the industry. Troy Leo's Almanac of Business \ Industrial Financial Ratios; It shows twenty-two financial ratios and industry-measure percentages for all major industries.Percentage ratios are presented for categories of twelve company sizes and for all companies in a given industry. Federal Trade Commission Reports; The FTC publishes quarterly financial data, including ratios for manufacturing companies. The FTC reports include analysis by industry group and asset amount.
Reference: http://www.joseacontreras.net/direstr/cap53d.htm
GUIDING VALUES OF FINANCIAL RELATIONS
References are attached showing “Optimal” Values to be used as a guide under “normal” conditions in different countries. They are shown as an example so that people who are their first contact with these tools have a general idea of the possible tentative values under a series of conditions to take into account in their analysis:
- http://es.wikipedia.org/wiki/Ratio_financiera http://proyectopromes.org/userfiles/file/finanzas.pdf http://www.slideshare.net/alrayon/ud-cy-f-t3-estados-contables (See: Guiding principles)http://www.franklintempleton.com.es/spain/jsp_cm/guide/glossary_r.jsp http://www.slideshare.net/Piedad1963/análisis-financiero-de-la-empresa-2703716
REFERENCE ARTICLE NOTES FOR GUIDANCE SECURITIES:
1) This index is closely linked to the cash forecast. In a well-managed company, it is essential to prepare budgets for income, expenses and planned investments, its sources of financing and some sheets or tables for forecasting collections and payments in the short term to better determine the optimal value of the ratio analyzed.
2) Indebtedness is generally preferable to LP and not CP. However, this is influenced by the interest rates achieved, the terms, the necessary guarantees, the financial possibilities of the company, the profitability of the investments to be financed and other various variables.
3) The ratio of the average payment term and the average payment term must reach values, the lowest and the highest possible. This improves the financing of the company, which will be supported by rapid collection from customers and remote payment to suppliers.
4) It is evident that the financial profitability or profitability of the capital invested by the shareholders or participants of the company, must at least match the other expectations that the capital market or other investment possibilities may be offering, at all times, To them
5) It can be decomposed into the three fractions of its formula, which, in turn, constitute three independent ratios. Thus, the financial return is:
Financial profitability = Sales profitability * Asset Rotation * Leverage
The different values of these three ratios can be combined in different ways, but it will always be better to obtain the highest possible total return.
In short, within the relativity of the values exposed for some of the indicators indicated, it may be a practical guide to compare those of our company, specifically, with those exposed and with those of other average values in the sector, and even with those of our geographical scope of activity. There are companies and specialized magazines that periodically publish data and statistics that reflect some of these types of data and average values of business management indicators by sector and line of business.
SECOND CHAPTER.
INTRODUCTION AND DEFINITIONS OF EBIT, EBITDA AND EVA
At the beginning of the second decade of the 21st century, more and more Financials use EBIT, EBITDA and EVA as financial indexes, in addition to the traditional Profitability, which is why they are mentioned in this document, to give an overview and the terms and the diverse opinions that exist about them are understood.
The origin of EBIDTA dates back to the 90s, becoming popular in the late 90s, in the midst of a technological bubble with internet companies and the oil boom. For example, it could happen that an oil company that was spending heavily on prospecting, it could perfectly well be that it was giving red numbers on its balance sheet, and yet that each day the company was worth more, when discovering deposits, than without having yet entered into operation, they did not produce income, but instead they increased the value of the company. With the intention of preventing this and other reasons from distorting the vision of the real valuation of the company, a different index was taken into account than that of the pure generation of benefits, EBITDA, result before interest, taxes, depreciations and amortizations,that it was intended to give an image of the company without circumstantial considerations distorting the valuation of the company. But like everything, the proper use accompanied by other parameters is good; But indiscriminate abuse as the only value to analyze a company can be catastrophic.
THE EBITDA is the gross operating margin of the Company; before deducting Interest, Taxes, depreciations and amortizations.
DEPRECIATION: It is the loss of book value that fixed assets suffer from the use to which they are subjected and their income-producing function. As the service time advances, the book value of said assets decreases
AMORTIZATION: It is the total or partial payment of the nominal capital of a debt or loan. They are the provisions made to offset the depreciation.
FINANCIAL CONSIDERATIONS AND OPINIONS
A fairly common mistake among NON-Financials is to consider EBITDA as a measure of the company's Cash Flow. The error comes from the fact that interest and taxes are real expenses, and therefore relevant in the calculation of Cash Flow. It also does not take into account the investments made, which according to the sector, can be very relevant. Linking EBITDA and Cash Flow would also mean assuming that all sales are collected, all debts are paid and everything that is bought is sold, which obviously is not the case.
Some financial analysts criticize it saying that it can be a “malleable indicator”, in whose calculation a “creative accountant” can make different assumptions, and therefore it is possible to get to “ make up ” the true results of an organization. Its calculation is easier to perform, while Cash Flow requires finer handling.
On the other hand, other financiers maintain that EBITDA has the advantage of eliminating bias in the financial structure, the fiscal environment (through taxes) and fictitious expenses (amortizations).
In this way, it allows to obtain a clear idea of the operational performance of companies, and to compare in a more appropriate way how well or badly different companies or sectors or projects do in the purely operational field as long as it is used as a measure of Profitability.
If the EBITDA of a project is positive, it means that the project itself is positive, and its success will depend on the treatment or management of financial expenses and the tax issue, in addition to depreciation and amortization policies.
EBITDA, for example, is not a sufficient measure when it comes to a project that, being highly financed by external resources, results in high financial costs, so that the success of the project will be in seeking a solution to financial costs. since EBITDA is positive, but high financing costs can seriously affect the final results of the project. The same happens with the tax part, depreciation and amortization. EBITDA, like all financial indicators, alone is not a sufficient measure to determine whether or not a project is profitable, but must be evaluated together with other indicators that evaluate other sensitive aspects of a project.
SEVERE CRITICISMS
- Professor J. Ramón Jiménez assures that EBITDA is one of the preferred weapons of Modern Financial Capitalism to defraud the investing public, the Treasury and the Judicial authorities. This use is related to the ENRON case, WorldCom, Natural Gas and especially He assures that it even touches large accounting and auditing companies, which falsified and manipulated the financial statements. John Percival, a professor at Wharton University, refers to EBITDA as EBIT-DUH, also highlighting its dangerousness since they consider them responsible for large part of the technological crack, with companies that are not profitable, and that show this data to cover their profitability problems. http://www.ehow.com/how_2060379_calculate-ebitda.htmlEBITDA is a financial calculation that is not regulated by GAAP (Generally Accepted Accounting Principles) and therefore can be manipulated for the own purposes of a company,
OPINION
In the impartial opinion of the writer of this document, and from a totally professional and ethical point of view, it can be said that EBITDA is a good indicator if it is used with caution and for what it is designed, and it is a dangerous indicator if it is taken as The only measure of a company's ability to generate cash.
EVA: ECONOMIC VALUE ADDED
The Economic Added Value (EVA) is calculated by subtracting from the Net Operating Income after taxes the opportunity cost charge of the invested capital. It is an estimate of the amount of earnings that differs from the minimum required rate of return (against investments of comparable risk) to shareholders or lenders. The difference can be an excess or a shortage of profitability.
The EVA is used to: Set company goals, measure performance, capital budget, stock analysis, and communication with shareholders and investors.
EVA is the difference between the operating profit that a company obtains and the minimum that it should obtain.
- The EVA is made up of three variables: UODI (operating income after taxes), cost of capital and net operating assets (capital employed). The EVA is the amount that results from subtracting from UODI, the financial cost that implies the possession of assets by the company. It can also be understood as the remainder of the net operating assets when they produce a return higher than the cost of capital. If the EVA is positive it means that the return of the operating asset is higher than the cost of capital since The inverse Increasing UODI without making any investment to achieve it is the best way to improve EVA. It should be noted that the increase in UODI occurs as a consequence of the increase in EBITDA. Investing in projects that produce RAN (profitability of operating assets),Higher than the cost of capital and freeing idle funds are the other two ways to improve the EVA. The RAN of a period can be higher than the cost of capital, with the EVA decreasing. The RAN used to obtain the EVA of the period must be calculated based on net operating assets at the beginning of the period, not the end.
The EVA is a measure of the added value of a given period, the important thing is that this added value increases period after period, that is, it must grow from one year to the next.
NOTE: EVA is a registered trademark of Stern, Steward and Cia de USA.
CALCULATION OF EBIT, EBITDA, NOPAT, EVA AND EBITDA MARGIN.
EBITDA is obtained from the Profit and Loss statement: it is Profit before discounting interest, taxes, depreciation and amortization.
It is convenient to use it as an indicator of Business Profitability, because it dispenses with Financial and Tax aspects, as well as accounting expenses that do not mean money outflow, so it could be used comparatively to evaluate results, either between the investment made or between sales made in a period of time by means of a comparison between several companies (horizontal analysis) or comparing the results of the same at different moments of time (vertical analysis)
Net Sales {or Operating Income} - Production Expenses = EBIT {Operating Income}
EBIT + Depreciation costs + Amortization costs = EBITDA
EBITDA margin = (EBITDA / Operating Income or Net Sales) x 100
EBIT {or Operating Margin or Operating Profit}
EBIT - TAXES = NOPAT {Net profit after tax}
NOPAT = Net Operative Profit After Tax
NOPAT - Capital Charges (Cost of Invested Capital x Cost of Capital) = EVA
EVA = NOPAT - Opportunity cost of the invested capital
Comparative table of the criteria for evaluating the profits of a company
- Ramón Jiménez. EBITDA AND CASH FLOW. University of Piura. FCA-UNAM.14 / 04 / 2003Cornejo, Edinson and Díaz, David: Measuring and Managin the Value of Companies USA Earnings Measures 2000 Edition 2000. Preparation and Evaluation of projects McGraw Hill Edition 2000. Chile.Serrano Samuel - Notes from accreditation classes for accountants METROPOLITAN REGIONAL COUNCIL - COLLEGE OF ACCOUNTANTS OF CHILE.Miras C. Antonio - Notes of Finance Classes Esc. Auditoria U. de ChileHéctor Alfonso Parra. How to measure liquidity and profitability status? The Relationship between EBITDA and Operating Cash Flows: The Case of the S&P 500Ben McClure. A Clear Look at EBITDA. http://www.investopedia.com/articles/06/ebitda.asp?partner=yahoobuzz#axzz1TvZ5OIPe Top 10 critical Fallings of EBITDA Sharon McDonnell. 2001 http://www.computerworld.com/s/article/55895/EBITDA EBDITA Description. http://www.valuebasedmanagement.net/methods_ebitda.html Gerardo Guajardo Cantú. Financial Accounting Editorial: McGraw-Hill. 2003, 4th edition Gabriel Sánchez Curiel Audit of Financial Statements Editorial: Pearson 2006, 2nd edition Joel Stern, John Shiely, and Irwin Ross. The EVA Challenge: Implementing Value Added Change in an Organization. John Wiley & Sons. 2001
